China's internet loan revolution

Peking University has developed an index which measures the growth and structure of internet finance across China. It says the industry grew almost fourfold in the year to December 2015 and, on one measure, the market was then valued at $US1.8 trillion).

"Internet finance may be a new development in China but its impact is now everywhere."
Shiro Armstrong, Editor, East Asia Forum

According to McKinsey, the internet economy is estimated to account for 7 per cent of GDP in China, compared with 4 to 5 per cent in the United States, Germany or Japan.

The most widely used internet finance service is third-party payments, a market dominated by two players, AliPay and WeChatPay, which at the end of 2015 had more than 270 million and 200 million active users respectively.

Online lending which includes both peer-to-peer (P2P) platforms and online micro credit is also expanding rapidly.

CreditEase is ranked as the largest P2P firm in the world, although it prefers to call itself a marketplace firm, because its borrowers include small- and medium-sized enterprises (SMEs) as well as individuals.

CreditEase’s platform Yirendai was listed on the New York Stock Exchange at the end of 2015. That same year, P2P lending reached RMB1 trillion. Ant Financial's Mayiweidai and WeBank's Weilidai are also rapidly expanding online lending businesses.

DIGITAL MONEY

The Chinese term for 'internet finance' was coined by Ping Xie and Chuanwei Zou in 2012. It's the equivalent of digital finance and fintech used outside China. But 'internet finance' covers both information technology (IT) companies providing financial services, such as WeChatPay, and financial institutions applying IT to their more traditional services, such as the e-ICBC service of the Industrial and Commercial Bank of China (ICBC).

Narrower definitions of internet finance embrace a wide range of activities, including third-party payment, online lending, direct sales of funds, crowd-funding, online insurance and banking and digital money.

Internet finance has been part of the finance scene in China for more than 10 years. AliPay was launched in 2004 and CreditEase was established in 2005.

But it was the launch of Yu'ebao, an online sales platform for money market funds established by Alibaba's Ant Financial Services, in June 2013 which marked the beginning of the recent explosive development of internet finance in China.

AliPay is used primarily by buyers and sellers engaging in e-commerce transactions, and it is also the main payment method on its sister site Taobao.

Money market funds or online direct-investment funds are sold directly through a platform of internet companies. Such companies act as no more than an intermediary and the money is actually handled by traditional, heavily regulated funds. The most in China is Yu'ebao.

P2P

P2P have been one of the most explosive growth internet finance sectors since 2014. There are more than 4000 platforms in China, attracting nearly three million people to lend their money. There are also famous P2P platforms outside China, such as Lending Club, Prosper and OnDeck.

Online direct investment fund sales are also quite active, with the best-known product being Yu'ebao.

Tianhong Investment Fund, which manages a money market fund for Yu'ebao, had assets worth RMB500 billion within a year of Yu'ebao's launch, becoming the largest investment fund in China. The previous top-ranked firm, the China Investment Fund, took 17 years to reach the same asset size.

Following the sharp decline of interbank market rates in 2014, Ant Financial launched another platform, Zhaocaibao, with the aim of selling wealth management products and investment funds.

At the end of 2015, the market size for such investment products reached an estimated RMB1 trillion. There are also a number of crowdfunding platforms, among which the most prominent are Angel Crunch and Demo Hour.

Two online banks, WeBank and MyBank, also received their operating licences in 2015, but growth has been limited by regulatory restrictions on the remote opening of bank accounts.

Among the public, internet finance invokes both fever pitch excitement and anxiety — sentiments of exuberance and pessimism reflected in public discussion and in the market.

GENUINE INNOVATION

Should we be worried about the explosive growth of internet finance in China?

Yes and no, say Yiping Huang, Yan Shen, Jingyi Wang and Feng Guo in a lead essay. Well known financial commentator on Weibo, Qilun Wu, argues P2P lending is a Ponzi scheme. Many share Wu's view.

But Huang and colleagues point out that there are good reasons for the rapid rise of China's internet finance industry.

The rise of internet finance in China has been triggered, on their argument, by three things: a repressive financial policy leading to undersupply of financial services, especially for SMEs and low-income households (this leaves a hole in the financial market that internet finance can fill); the tolerance of regulators, providing space for internet finance to emerge and grow; and IT tools, especially mobile terminals and big data analysis, that offer effective ways for internet finance to lift financial efficiency and control financial risk.

Sure, “many in the game of internet finance in China today are probably not ideally qualified. This, rather than the core of the industry itself, is why the internet finance industry is suffering from bubbles and scandal at present. The industry needs a shakedown”, Huang and colleagues say.

But “internet finance in China fills an important gap in the market by extending financial services to customers who are insufficiently serviced by the traditional financial industry … it facilitates financial transactions in general by lowering costs and reducing risks through better use of customer analytics data — by reducing information asymmetry. On these two counts, internet finance delivers genuine innovation.”

The conditions for healthy development of the industry, they conclude, are: strong internet infrastructure; control of industry qualifications and standards; and regulation that strikes the balance between financial innovation and managing risk.

Too little and too much regulation could hinder the otherwise beneficial evolution of internet finance that is also helpfully keeping the pressure up on Chinese financial market reform.

Shiro Armstrong is editor at East Asia Forum, where this story originally appeared.